Benchmarking in micro-lending : Working towards best practices

This research project was led by the Institute for Financial services (IFF) in Hamburg and co-financed by the DG XXIII of the European Commission. The other project partners were:

• Personal Finance Research Centre (PFRC) in Bristol, UK
• CASA, Copenhagen, Denmark
• FACET, Zeist, The Netherlands

FACET was responsible for producing the draft of this handbook.

The objective of this research project was to identify successful experiences of micro-lending in Europe and the USA, in order to support new micro-credit initiatives set up by credit providers both within and outside the traditional banking sector.

Micro-entrepreneurs, defined as those who need loans between 1,000 and 25,000 EURO, are often considered a very risky client group for banks, because they lack either collateral or the capacity to convince banks that they are able to get and repay a business loan. Micro entrepreneurs usually have no track record in business and lack the financial records that the formal sector requires to make a loan. The costs of processing small loans and the risks involved in lending to micro businesses make financial institutions hesitant to develop serv-ices for micro entrepreneurs. All these factors inhibit access to credit among this group.

Micro-lending is distinct from mainstream banking in the following ways:

• non traditional criteria for assessing creditworthiness
• non traditional collateral accepted
• loan officers are not necessarily bankers
• credit is provided alongside business support services
• credit amounts are between 1,000 and 25,000 EURO

These differences make micro-lending successful in promoting the establishment of small and single person enterprises. The potential clients typically do not have access to main-stream credit provision because they lack steady employment or a solid credit history as security and are, therefore, considered to be risky clients. In addition, the amounts needed are often small and, therefore, the transaction costs are high.

In short, the most significant problem for lenders, is the combination of the high risks and high costs of micro-lending. However, international experience has shown that the "uncred-itworthy" are able to repay loans and, through self employment, to become independent from state-provided income support. These people include, for example, redundant employees, young graduates, immigrants or single mothers.

The research project aims to formulate answers to the following questions:

1. What is the most efficient way to assess creditworthiness?
2. How can loans be made without the traditional forms of security?
3. How can entrepreneurs best be supported, in order to lower the failure rate of start-ups?
4. What is the most efficient way of attracting potential clients?